Earnings Reports Are Meaningful…Or Meaningless

Transcript

As many of you are probably aware, publicly traded companies are required to release earnings reports every quarter to provide their shareholders with an update on their financial situation. As soon as these earning reports are released, they are scoured over with a fine-tooth comb by investors, and especially by the media. Now, I don’t want to suggest that these reports are useless. Not at all.

But in my experience, after reading hundreds of these reports and listening to the related conference calls, I think the real purpose of releasing this information is not to actually help investors better understand what is going on with the company, but instead give management an opportunity to become cheerleaders for their stock price.

Welcome to the second season of Invested Poorly: Sad Tales of FInancial Fails, a short-form podcast designed to help everyday investors make wiser investment decisions by learning what NOT to do with their money. Host Jeff Harrell shares timeless stories from his former life as a financial advisor, about the poor—and irrational—choices he witnessed investors make that disrupted their journey to financial independence, or FI. Your ability to recognize, and avoid, similar mistakes could make all the difference for you along your path to reach FI.

Check out the “Introduction” episode for more background on Jeff, why he created this podcast, and how it can guide you to becoming the hero of your own investing story. Now, on with show.

Doesn’t it feel great to wake up to a headline mentioning one of your largest stock positions reported earnings and beat expectations. This usually provokes a feeling of excitement, and you can’t wait to look up the stock to see how much the price has changed. I have to admit, when I was early in my career, I fell into this trap just like everyone else. But as time went on, I found these reports to become more and more meaningless. Especially after I gained a better understanding of exactly how the expectations are established.

You know, it always seemed odd to me that way more than 50% of companies managed to beat expectations every quarter. I’m not sure if you will agree, but my logic goes something like this: If the earnings expectations we see are real, then the odds of beating expectations should be around 50%. I mean, it seems reasonable to me that with all the analysts out there researching publicly traded companies, over time they would collectively be right half the time and wrong the other half.

Well, that is definitely not the case. According to the Seeking Alpha article I reference in the show notes, from 2000 through 2022, roughly 70% of companies have regularly beaten earnings by 5% or more. And I have no doubt this number is accurate because my career began in 2000 and 70% seems perfectly in line with my experience.

So what do you think? Are analysts just really bad at estimating earnings, or is there something more going on here? When you start digging a little deeper into the numbers, you’ll find out that over the years companies have become better and better at managing earnings expectations.

I also included a link to an article from Investing.com in the show notes that discusses how companies beat estimates during earnings season, so if you want the nitty gritty details on how this works, be sure to check it out. Essentially, the article illustrates how management will guide analysts to predict earnings at a level they feel reasonably confident they can beat using all kinds of accounting methods. Unfortunately, the article will probably only reinforce the questionable motives within the financial services industry.

I will warn you that you will need to register for a free account to access the two articles I’ve mentioned, but I think both sites are worth signing up for because they provide additional articles that I think you can learn from.

Or, if you don’t want to sign up to read those articles, another option is to take my inquisitive little nephew’s advice and “search it up.” Trust me, you will have no problem finding articles discussing how companies manage earnings expectations by guiding analysts to set them low enough so they can beat them as frequently as possible.

Over the years I would often get emails from clients asking about why we were still holding a stock that had just reported an earnings miss. I’m telling you, it was hilarious to see the questions some people would come up with. In almost every case, the client had not read a single word of the actual article. It was almost always the headline they were referencing. This focus on the headline, of whether or not a company beat earnings, is why management is so concerned with managing earnings expectations.

The most blatant and obvious example of managing earnings expectations comes from big technology companies. It was comical to me how often the biggest and most popular technology stocks would beat earnings expectations. As I already mentioned, the overall market beats expectations 70% of the time, but big tech seemed to be on a whole other level. In my experience, it seemed like these companies beat 90% of the time, with some of these companies having gone years without missing a quarterly earnings estimate. I mean, does that make any sense at all?

So, quick side note for any of you out there looking to change careers. Given how consistently these companies beat earnings expectations, my advice would be to apply to be an analyst covering large cap technology stocks. All you have to do is average all of the other analysts’ current earnings estimates for the biggest technology stocks in the market and make your estimate around 5% higher. Although I obviously can’t guarantee this, my educated guess is you will be one the most accurate analysts in the industry. Yes, you are picking up on my sarcastic personality, but the sad thing is, I think there is a lot of truth in what I’m saying.

So, I wanted to keep this episode short and sweet because the point I’m trying to make very clearly is that earnings reports are probably not as helpful as you might think they are. I’m not saying they are useless, but now that you are armed with a little more information, you can decide for yourself how much value you put on earnings reports and what type of actions you may take as a result. For me, this serves as another reminder to “ignore the noise.”

I sure hope you enjoyed this episode of Invested Poorly and will be able to take something from it to improve your decision making as you navigate the twists and turns of your personal investing adventure. Be sure to check out my website at AreYouFI.com (that’s A R E Y O U F I dot com) where you can find resources and show notes with the charts and graphs I mention during the episodes. These are like little treasure maps that can help you choose more wisely along your quest to reach FI, or financial independence.

Never forget, in the short-term the stock market is unpredictable, and as my mischievous little nephew likes to say, “things just happen”! So focus on the long-term, by controlling your emotions, simplify your investments, and always… ignore the noise.

I’m your host, Jeff Harrell.  Thanks for listening.

Invested Poorly: Sad Tales of FInancial Fails was created for informational purposes only and should not be relied on for specific tax, legal, or investment advice. You should consider consulting a qualified professional to review your situation before engaging in any transactions. Investing involves risk, including loss of principal and past performance is no guarantee of future results. 

This podcast was produced by Ted Cragg. Learn more about creating podcast mini-series like this by visiting QuickEditPodcasts.com.